Revisiting cross-border e-commerce: What did the "most beautiful" Temu do right?

Recently, with the explosive performance and stock price of PDD, the market's attention to Temu, the main source of unexpected performance, has also increased. Based on PDD's financial report, it seems that Temu is not far from the breakeven point. The question of how Temu, which promotes extreme low prices, can rapidly grow its GMV during the investment period while also narrowing its losses is a puzzle that the market cannot solve but has to study. On the other hand, due to the continued "lying flat" trend in the domestic economy, domestic e-commerce platforms cannot see a way out, and going overseas has become a unanimous choice for major platforms to seek additional growth.

Therefore, following the preliminary discussion on the cross-border e-commerce industry in the previous article, this time we will analyze the differentiation and pros and cons of this business from the perspective of the business model of cross-border e-commerce. We will explore what Temu has done right and has achieved astonishing growth in the cross-border e-commerce industry, which has actually been around for more than ten years.

After research, first from the perspective of the business model of cross-border e-commerce vs. overseas local channels:

① "Cost-saving": The cost-saving aspect of cross-border e-commerce is undeniable, but it mainly applies to white-label products. For branded/common products, the price advantage of cross-border e-commerce over overseas local channels will be narrowed.

However, what is counterintuitive is that although a large number of products on cross-border e-commerce platforms are sold for less than $10, the gross profit margin of cross-border e-commerce is still at least around 40%-70%. This is essentially the difference between high consumer spending power overseas and low production costs in China, and it is the cornerstone of the profitability of cross-border e-commerce.

② "Variety": Taking Temu and Amazon as examples, the difference in the number of products between cross-border e-commerce and overseas local channels is nearly 10 times. The fundamental reason is that cross-border e-commerce is a supplement to the supply chain that traditional export channels, such as domestic white-label products, do not cover (or are not worth covering). If it does not transform into localization, there is a clear limit to its product categories and target audience.

③ "Speed": Similarly, it is counterintuitive that the average fulfillment cost of cross-border air freight small parcels is lower than that of trunk shipping + overseas warehouses + last-mile delivery (taking Amazon as an example). The fundamental difference between the two fulfillment models lies in the trade-off between high fulfillment efficiency + high inventory risk and low fulfillment efficiency + low inventory risk, rather than cost.

④ Merchant UE calculation: Taking Amazon and Temu as examples, the operating profit margin of merchants under the two models is not much different, but due to the huge difference in pricing, the absolute profit of merchants on Amazon can be 3-4 times higher than that on Temu. At the same time, for the platform, Amazon's net realization rate (after deducting fulfillment costs) can exceed 30%, while Temu's is currently slightly over 20%. In other words, Temu squeezes profits from merchants and the platform itself and transfers them to consumers. From the perspective of cross-border e-commerce comparison, it is more direct to say that Temu competes with Shein and AliExpress, rather than competing for overseas local channels.

What sets Temu apart and allows it to grow rapidly is its fully managed model. Under this model, the platform takes on or replaces the functions of multiple layers of distributors, and passes on most of the profits released from the shortened supply chain to consumers, attracting more consumers and creating a cycle of more consumers and sales.

At the same time, under Temu's fully managed self-operated model, the platform takes on tasks such as purchasing goods, demand analysis, product pricing, marketing promotion, pre-sales/post-sales services, etc., which are usually the responsibilities of merchants in the marketplace model. Therefore, for small-scale businesses and manufacturers who lack the ability to price and promote in the cross-border market, Temu fills the gap in the supply of these neglected goods and provides significant growth opportunities for these businesses.

However, for cross-border merchants with mature operations, most of them use Temu to clear out excess inventory. Platforms like Amazon, which can independently set prices and obtain higher profits, are still the focus for these merchants. But the fully managed model is not universally superior to the marketplace model. No matter how efficient a company is, the breadth of the supply chain it can manage on its own is limited, and third-party merchants are an inevitable choice for enriching products and increasing scale.

Based on the above analysis, Dolphin Research currently evaluates Temu as follows: if we do not consider the localization transformation, Temu's GMV ceiling should not be overestimated on the topline. Although Temu has its own differentiated advantages, the upper limit of cross-border e-commerce means that after crossing the stage of national/market expansion, Temu's scale is unlikely to have a significant difference from Shein or AliExpress. Due to the limitations of the adapted merchant and consumer groups, the average order value is also unlikely to have a high room for improvement.

However, on the bottom line, after analyzing the efficiency and profit margin space of cross-border e-commerce, it is no lower than that of overseas channels. Therefore, in a steady state, achieving a single-digit operating profit margin should not be a problem. With the profitability turning positive, the market is likely to start factoring in Temu's valuation.

The following is the content of the analysis:

I. "Save, More, Fast, Good": What makes cross-border e-commerce different

1."Save": Even cheap, there is still considerable profit margin

It is obvious that the biggest advantage of domestic cross-border e-commerce platforms going global is the low prices of goods (backed by lower production costs domestically and abundant, even surplus, supply of goods). However, the meaning of "cheap" in cross-border e-commerce varies in different contexts:

① For products with relatively low absolute prices, Temu has a higher price advantage compared to Amazon (as a representative of local channel prices overseas), while for products with relatively high absolute prices, Temu's price advantage is significantly narrowed. According to the statistics of randomly selected products, for products priced below $10, Temu's prices are more than 50% lower than the average price on Amazon. However, for high-priced/branded products priced above $30, Temu's average price advantage is less than 20%.

The logic behind this phenomenon has been discussed by Dolphin Research in the previous analysis. The price advantage essentially reflects the differences in supply chain between different channels and different products. On one hand, for well-known or popular products such as smartphones and robotic vacuum cleaners, the coverage of the supply chain by domestic and cross-border channels is generally the same. Therefore, in these well-known/popular products, domestic cross-border e-commerce platforms do not have a significant supply chain (i.e. price) advantage compared to overseas local channels.

On the other hand, it is difficult or economically not worthwhile for overseas channels to cover low-priced and high-volume white-label or long-tail products. Therefore, cross-border e-commerce platforms have more obvious price and supply advantages in these products.

When comparing across platforms, both Temu and AliExpress have prices that are nearly 60% lower on average compared to Amazon. The discounts are generally the same. From this perspective, it seems that Temu does not have a significant price advantage compared to AliExpress for low-priced products (the sample size is limited and cannot reflect the whole picture, according to research, Temu's price advantage over AliExpress may be around 10%). However, this still indicates that Temu has achieved explosive growth from zero to an annualized GMV of over $20 billion in just over a year, not simply because Temu has a particularly obvious price advantage compared to existing cross-border platforms. We will provide a more detailed analysis on this later.

In addition, it is counterintuitive that on one hand, the prices of products on cross-border e-commerce platforms generally "appear" to be very low (even with a large number of flash sale items priced at $0.99), while on the other hand, cross-border shipping requires high transportation costs. Therefore, one would intuitively think that cross-border e-commerce is a business model with "low selling prices but high costs," and have doubts about the profit margin of this business.

However, in reality, even for products on Temu priced below $2, they are generally 2-3 times higher than similar products on 1688.com. Considering that there is also profit margin for products on 1688.com, the "seemingly low-priced" products on cross-border e-commerce platforms actually have a significant profit margin (60%-70% or more).

3. "Fast": The trade-off between delivery time and cost in cross-border direct shipping

From the perspective of "fast", which refers to the delivery time, cross-border e-commerce naturally has a lower timeliness compared to domestic channels, unless there is local warehousing for pre-stocking. According to Temu's official disclosure, the (limited-time) free standard delivery takes approximately 7-12 days, while the expedited delivery, which incurs a fee, takes approximately 5-9 days. In comparison, in recent years, Amazon's delivery time in the United States has generally been within 1-3 days. Research shows that for consumers of cross-border e-commerce, price and delivery time are not the most important factors. In other words, low price and slow delivery are accepted as a trade-off. Multiple user surveys conducted by Dolphin Research (the following image is just one example) show that what cross-border e-commerce consumers care most about is whether the delivery is free and whether returns are convenient.

Since consumers are unwilling to directly pay for the cost of cross-border transportation, for cross-border e-commerce platforms, controlling the cost and reliability of logistics may be the second most important factor after price. After analysis, it is not necessarily incorrect to assume that the overall fulfillment cost of cross-border e-commerce is higher than that of traditional trade channels.

Firstly, logically speaking, in the three major processes of initial transportation, trunk transportation, and final delivery:

In terms of initial transportation, there is not much difference between cross-border e-commerce and traditional trade models, and there is not much room for improvement in efficiency.

In trunk transportation, cross-border platforms also use dedicated lines/charter flights, which is basically the same as traditional trade in terms of economies of scale. The core difference is that traditional trade can use cheaper sea transportation because most of the goods are stocked in advance, while the just-in-time delivery model of cross-border e-commerce is "forced" to use more expensive air transportation due to time constraints. This is also an area where there is room for improvement.

In terms of final delivery, cross-border e-commerce generally outsources it to overseas express delivery companies, while traditional trade models mostly rely on distribution channels to fulfill the final delivery. This article does not explore the efficiency and cost of direct mail and overseas distribution channels, but considering the distribution and warehousing costs of multiple layers of distribution channels, the final delivery cost of cross-border e-commerce is unlikely to be higher than that of traditional trade models.

Taking the above three points into consideration, the delivery cost of cross-border e-commerce in initial and final transportation is not higher than that of traditional export trade. The main difference lies in trunk transportation, where traditional trade can use sea transportation + local warehouses, while cross-border e-commerce mostly uses more expensive air transportation. However, the essential difference between these two models is not just the cost, but the former needs to bear inventory risks, while the latter does not.

In terms of quantitative analysis, according to recent research, Temu's average fulfillment cost is currently around $11-$12, accounting for about 28% of the average order value of $37-$38.

In comparison, the delivery cost for a 16oz (approximately 500g) package under Amazon FBA is about $7.5. Assuming the value of the package is $30 (Amazon's average order value), the last-mile delivery cost accounts for about 25% of the selling price. Adding the first-mile delivery cost of transporting goods to Amazon's warehouse, the overall delivery cost for cross-border merchants on Amazon can account for 30-35% of the selling price.

Comparatively, both the absolute value and the proportion of Temu's delivery cost to the selling price are lower than Amazon's total fulfillment cost. In other words, the direct mail mode does not have a cost disadvantage, and may even have a cost advantage compared to the mode of long-haul shipping + local warehouse + last-mile delivery. Taking into account the different inventory risks associated with direct mail and local warehouse modes, direct mail becomes even more cost-effective.

Considering the cost and efficiency, the direct mail and local warehouse modes are actually a trade-off between lower cost and inventory risk versus higher efficiency.

4. Comparison of User Experience: Struggling for both merchants and themselves, benefiting consumers

In the previous sections, we qualitatively analyzed the differences and advantages of cross-border e-commerce models from the perspectives of "saving, variety, speed, and quality". Next, Dolphin Research will use Temu as an example of a cross-border e-commerce platform and Amazon as an example of an overseas local channel to analyze the different components of UE (User Experience) on these two platforms, as well as the different distribution of benefits among consumers, platforms, and merchants.

Based on the above diagram, let's look at each specific item:

① Selling Price: According to research, Temu's average order value is around $37-$38, with an average item price of about $7. Therefore, let's assume that a product A is priced at $7 on Temu.

Referring to the research and the difference in average order value between Amazon and Temu, we assume that the same product A is priced at $21 on Amazon, three times the price on Temu.

② Fulfillment Cost: Amazon's logistics cost is calculated at 35% of the item price mentioned earlier, which is about $7.4. Temu's logistics cost, according to the research, is about $1.9 per item (accounting for 27%). ③ Platform monetization: Amazon's commission rate is approximately 17%. In addition, under the platform model, merchants also need to invest in advertising, which is about 15% of the item price.

Under the fully managed model, according to calculations, Temu's current markup rate is about 50%. After deducting fulfillment costs, the net monetization rate is about 23%. However, Temu currently does not have advertising monetization for merchants.

④ Merchant profits: Based on the different pricing, fulfillment costs, and platform monetization of Amazon and Temu, and assuming the same cost for the same product (80% of the supply price on Temu), in this example model, it can be calculated that the average operating profit per order for merchants on Amazon is approximately $2.1 (10% of the selling price), while the average operating profit per order on Temu is $0.6 (approximately 8% of the selling price, 12.5% of the supply price).

In summary:

① For merchants, the profit margin is similar when operating on Amazon or Temu. However, due to the significant difference in pricing, the absolute average profit per order differs by nearly 4 times. In other words, for merchants capable of cross-platform operations, Amazon is a more profitable platform (consistent with the feedback from the survey).

② For platforms, after deducting the different fulfillment costs of the two models, Amazon's net monetization rate is about 32%, while Temu's is about 23%. From the platform's perspective, Amazon is also more profitable.

③ But for users, Amazon's prices are three times higher than Temu's, in exchange for the same product but faster delivery and a more familiar and trusted platform service.

In other words, under the Amazon model, both the platform and merchants have greater profit potential, while Temu is a shared sacrifice of profits between itself and merchants to provide consumers with more benefits.

II. The advantages and disadvantages of the fully managed model, "service" or "substitute" for suppliers

Above, we have discussed the characteristics, advantages, and value propositions of the cross-border e-commerce business model for different users or merchants. However, we know that cross-border e-commerce is not a new business model. Predecessors such as AliExpress and Shein were established more than 10 years ago. So, what differentiated advantages does Temu have, as a company that has been established for just over a year, to achieve such explosive growth in this not-so-young industry?

At the same time, the comparison between cross-border e-commerce and overseas local channels is not simply a matter of comparing prices. The two have significant differences in terms of price, product variety, timeliness, and other aspects, so their target user groups also differ greatly.

In comparison, the more direct competition lies within the cross-border e-commerce industry, which has a closer resemblance in terms of business models and user groups. According to Deutsche Bank's research, the platforms that consumers reduce their consumption on the most after using Temu are AliExpress, Shein, and Big Lots. In other words, instead of overly focusing on the pros and cons between Temu and Amazon, and when Temu can capture how much market share from Amazon, the more realistic and crucial question is whether and why Temu can surpass AliExpress? **

So fundamentally, Dolphin Research believes that the biggest difference between Temu and AliExpress lies in the fully managed (self-operated) model adopted by Temu.

In general, e-commerce platforms can be categorized into two types: self-operated (including fully managed) and platform-based (marketplace). Simply put, the most obvious difference between the two lies in the fact that the former sells products to consumers directly, while the latter allows merchants to sell products to consumers. However, behind these subtle differences lies a completely different business model.

① Different target audience: First and foremost, the most significant and fundamental difference between Temu (fully managed, self-operated) and AliExpress (mainly a marketplace) lies in the different target audience they serve. Temu serves consumers, while AliExpress serves merchants.

Although this difference may seem obvious, it determines that Temu's primary goal is to sell more products to more consumers. As mentioned in the previous analysis of UE, Temu simultaneously squeezes its own and the merchants' interests in order to provide consumers with the best prices and services. Merchants, on the other hand, are only suppliers to Temu, and their interests do not need to be prioritized. They only need to ensure that they are profitable.

While AliExpress also values the consumer experience, its core focus is to serve the merchants on the platform and help them earn more money. Selling goods to consumers is essentially a way for merchants on the platform to make profits.

Therefore, for consumers, the difference in the two models determines that the former is a more cost-effective choice and is more attractive to consumers.

② Different responsibilities: The second major difference between the self-operated and marketplace models lies in who bears the responsibility of the operational entity. In the marketplace model, merchants are responsible for functions such as procurement, demand analysis, product pricing, marketing, pre-sales/post-sales services, etc. In the fully managed, self-operated model of Temu, merchants are basically "hands-off" except for supplying goods.

This means that in the marketplace model, merchants have the ability to set prices independently, which leads to higher profit margins, but they also have to bear more operational burdens and risks. On the other hand, Temu suppliers have smaller profit margins and less operational burden. ③ Summary: Combining the above two points, the innovation of the Temu model lies in the fact that the platform takes on most of the functions in the supply chain, greatly reducing the hierarchy of the supply chain and connecting manufacturers and consumers. The profits released from the shortened supply chain are mostly passed on to consumers, with only a small portion retained by the platform.

However, Dolphin Research also needs to point out that the full-service model is not necessarily superior to the marketplace model in all aspects. The reason is that no matter how efficient a company is, the breadth of the supply chain it can manage on its own is limited. Third-party merchants are an inevitable choice for enriching products and expanding business scale. However, in the early stage of volume accumulation, the self-operated model can still achieve higher operational efficiency and provide a better consumer experience.

In fact, according to research, for mature cross-border merchants, most of them use the Temu model to clear out excess inventory. Platforms with higher profits, such as Amazon, are still the main platforms. For smaller merchants or manufacturers who lack the ability to independently price and market their products in the cross-border market, Temu can fill the gap in the neglected supply of goods.

III. Regulation may be an unavoidable obstacle for cross-border e-commerce

In addition to the discussion on the model and operation of cross-border e-commerce, policy issues are also a major concern for investors in cross-border e-commerce. Although we cannot accurately speculate or judge the subjective intentions of the government, as Dolphin Research's subjective judgment, I believe that regulation of cross-border e-commerce is basically inevitable from a logical perspective.

Looking at historical cases, governments in India, Russia, Indonesia, the United States, and the European Union have all implemented restrictive policies on cross-border e-commerce in recent years. Please refer to the table above for detailed cases.

From a logical perspective, as the Indonesian government has stated, if a foreign company cannot bring employment or upgrade the local industry chain, and at the same time competes with local companies while "escaping" from paying taxes to the local government through tax exemptions, it is normal for both the government and the company to not allow the company to continue to grow and even dominate the major market share.

The mildest form of regulation may be the cancellation of tax benefits, while the worst-case scenario may force localization, require the establishment of joint venture companies, or even completely ban the company, as the Indian government "unreasonably" did. However, of course, the situation where operations are completely impossible due to regulation is obviously rare. The most likely impact is a certain degree of pressure on the profit margins of cross-border platforms.

Dolphin Research's previous studies on cross-border e-commerce:

Cross-border E-commerce

October 18, 2023, "Following the Trend of Going Global: Is Cross-border E-commerce a 'Promised Land' or 'Mediocre'?" Domestic E-commerce

October 10, 2023: "Against the Wind: Can Alibaba, JD.com, and Meituan Make a Comeback?"

April 12, 2023: "Battle of Cost-effectiveness: When Will Alibaba, JD.com, and PDD Stop Competing?"

January 5, 2023: "The Tide Turns: Alibaba, Ctrip, Didi Ready for a Counterattack"

September 30, 2022: "PDD vs Vipshop: Your 'Hard Times' Are Their 'Good Times'?"

September 22, 2022: "Alibaba, Meituan, JD.com, PDD: Have They All Accepted Their Fate?"

April 27, 2022: "Alibaba vs PDD: After the Battle, Only Coexistence Remains?"

April 22, 2022: "Meituan, JD.com: Why Are They Excelling in the Intense Competition?"

April 13, 2022: "As the Cycle Declines, How Much Value Do Alibaba and Tencent Retain?"

Risk Disclosure and Disclaimer: Dolphin Research Disclaimer and General Disclosures